Over the decades, there has been a multiplication of different financial instruments trading on open financial markets and over-the-counter (OTC) trading markets. Generally speaking, each financial instrument serves a unique function and resolves a specific financial need absent from the market. One of the most stable type of financial instruments is a debt inspired security called bonds. Bonds are debt obligations, most often low interest-bearing, stable and issued by large corporations, municipalities and governmental organizations as a means of generating cash for expenditures. Most retirement portfolios are made of multiple funds each a basket of bonds, stocks, or even commodities. A bond is a certificate obligating the issuing party known also as the issuer, the borrower or the seller to make regular interest payments via a trustee to the bond holder/investor and ultimately at the term/maturity of the bond pay back the principal borrowed at face value. What is described is one type of bonds, one of ordinary skill in the art will understand that different types of instruments exist each having different features and properties.
Unlike conventional loans between two fixed people, unlike commercial paper, bonds are more easily transferable over OTC exchanges. The bonds are often for large sums and investors are often broker/dealers who will trade large sums at once. One of the biggest obstacles to the free trade of bonds is the inherent complexity and opaqueness introduced via market agents operating OCT markets.
As part of the bond loan agreement, the issuer pays the holder a specified amount of interest and delays to the term refunds the principal (either fixed or variable) on a specific term date. Bonds are generally issued as a package called a single issue for a total sum and with a fix rate of interest, having a fixed maturity date in a distant future. Other bonds are offered with variable rates reset periodically. When bonds are first offered as new issues, they are introduced in what is called a ‘primary market’ where the money raised by banks or large brokers from the sale goes to large initial investors (buyers) to the issuer (seller) minus a commission taken by an intermediary such as a broker/dealer or a syndicate bank/dealer.
Once the primary market introduction is complete and ownership has transferred to initial investors, the single issue is then pushed to be traded either on the over-the-counter or in any one of other venues where the instruments can be traded. In fixed interest rate bonds, the initial primary issue borrower normally takes little or no financial interest in the subsequent trade on the secondary market, aside from observing the initial value given by investors. With variable interest bonds, the purchase price is left to float with demand. Some variable interest bonds have fixed value and maturity par value but the intermediate periodic rate varies. Other bonds for example are indexed and vary based on a leading indicator. Since the issuer must make periodic variable interest payments, what is preferred for the issuer is a bond that generates is traded at the lowest interest rate. A buyer or investor on the other hand desires bonds who offer the higher possible interest rate. Other important factors exist that increase the desirability of bonds, for example their long term stability, the tax exempt status of interest paid, etc.
Bonds even in a secondary market are not traded at a physical exchange the same way stocks are traded on the DOW™, or the NASDAQ™. Rather, bonds are often traded over-the-counter in trading rooms by agents of exchanges and brokerage firms. As part of the OTC process, an intermediary broker/dealer has to be contacted who will take a commission on any transaction. Delays are to be expected and fees are often charged. The mere existence of these intermediaries create a barrier to trading, an undesirable spread and will increase the costs to the seller and the returns on the buyer. What is desired is a method, system, platform, and financial instrument designed to bypasses the OTC processes while keeping the advantages associated with these bonds.
Some banks called ‘market-makers’ buy and sell bonds in exchange of a commission. These market-makers also use broker's-broker to help the transaction between a dealer and a dealer bank. The broker's-broker works for a stated commission while the market-maker will pocket the difference between a ‘bid’ price (the price bonds are sold by investors) and a ‘offer’ price (the price bonds are purchased by investors). The difference between the bid and the offer is a ‘spread.’ Ultimately, reduction of the spread is desirable in any given transaction to help investors benefit from a better offer price for any bid price thus increasing the value of a bond. The use of online trading platforms for bonds is desirable over these labor intensive exchanges.
U.S. Pat. No. 5,915,209 discloses a computerized municipal bond trading system capable of conducting a private electronic auction of bids between the central market-maker and multiple remote clients who are prospective bidders. As described in this reference, a broker compiles a list of bonds received from various traders and firms into a central listing of offering as part of a secondary market. Traders participate in silent auctions via facsimile. This system is not interactive, and the user is not allowed to search the bonds for trade. FIG. 1 is a diagram from this reference illustrating this trading system.
U.S. Pat. No. 6,161,099 discloses an apparatus and process for conducting municipal bond auctions over electronic networks. The auctioneer maintains a web site from which information about the bonds to be auctioned can be accessed, browsed and used with great difficulty. Users access the website site via a conventional internet browser after the verification of a user's identity. The system once again only serves to facilitate silent auctions. User interaction is extremely limited and searches are not really enabled.
U.S. patent application Ser. No. 12/186,501 teaches a more interactive online system where a user can select as shown at FIG. 2 between a silent auction, a direct non-competitive environment, or by-passing the automated functions through a broker to confirm trades. At FIG. 3 also taken from the same reference, the interface allows for the calculation of fees to allow users to anticipate the overall cost associated with any given trade by adding the commission component to the projected bond yield. This reference allows for the creation of trade reports, management of user history and activity, and some limited back office service for regulatory governmental institutions. The system contemplates silent auctions, and offers simplified search tools. This system allows for the trading of normal bonds and does not alter the way bonds are traded to give these bonds better long term ratings. What is needed is an interface capable of creating a trading environment where long term properties of bonds can be altered to benefit the borrower and the investors.
Some bonds, like municipal bonds are debt obligations issued by state and local governing bodies to support financing needs of these bodies. Default of states, cities, or countries is rather rare as it would result in immediate political backlash for some elected official and therefore these bonds rarely default and are rather low risk. Further, interest paid on some of the municipal bonds can be free of federal tax and, under certain circumstances, free of state and local taxes. But a low rate associated with a distant maturity date can be a significant obstacle to the sale of bonds, for example if inflation rises above the interest rate, the net benefit from holing the bonds disappears. Therefore, some bonds are designed with built in variable rates that fluctuate over time.
The Municipal Securities Rulemaking Board (MSRB) serves as the official source for municipal securities disclosures and related market data. The MSRB operates the Electronic Municipal Market Access (EMMA) system and offers an on-line centralized disclosure database of information relating to many securities. EMMA statements include on-going disclosures, escrow deposit agreements for advance refunding, real-time municipal trade price information, interest rates and auction results, and interest rate reset information for Variable Rate Demand Obligations (VRDO) together with daily statistics on trading activity and investor education materials.
VRDO are one type of financial investments and securities as contemplated in this disclosure. VRDOs are a common form of bond that pays interest based on a variable rate, that is, a rate of interest adjusted from time to time based on pre-determined conditions built in into the bond as conceived prior to the time of introduction on the primary market. Brokers help advise debt issuers as to the best conditions to build into VRDOs. VRDOs often have maturity dates far into the future (up to 30 years) but are treated as short-term investments because an investor is given a ‘put’ right, or the right to require that the issuer or its agent repurchase the bonds from the investor at the full face value of the VRDO at the expiry of any periodic period where the interest is reset. The put held by the owner gives holders the right to migrate away from the bonds in case of catastrophic market conditions change.
Currently, there are many different ways in which the interest rate can vary, each is spelled out in the bond documentation. In the most common form, rates are reset on a specific schedule of periodic adjustments based on best estimate of a broker-dealer or bank acting as remarketing agent reselling to investors at full face value the VRDO at the then-current rate. For other VRDOs, the rate adjustments is based on a formula pegged to a financial market rate index or other interest rate measurement. The periodic resets typically occur daily, weekly, monthly, semi-annually, annually, or even less frequently based on each bond issuance. The frequency of interest payment for variable rate bonds typically is dependent on the frequency of the periodic interest rate resets.
In 2008, the principal ARS auction market failed. As a consequence, many holders of ARS products were unable to transfer their ownership interest. Part of the reason associated with the failure is the ARS market opacity and its fragmentation. What is needed is new competitive bidding market to promote efficiency and transparency.